WASHINGTON, July 16 (Reuters) - A "pervasively polluted"
culture at HSBC Holdings Plc allowed the bank to act as
financier to clients seeking to route shadowy funds from the
world's most dangerous and secretive corners, including Mexico,
Iran, the Cayman Islands, Saudi Arabia and Syria, according to a
scathing U.S. Senate report issued on Monday.

While the big British bank's problems have been known for
nearly a decade, the Senate probe detailed just how sweeping the
problems have been, both at the bank and at the Office of the
Comptroller of the Currency, a top U.S. bank regulator which the
report said failed to properly monitor HSBC.

"The culture at HSBC was pervasively polluted for a long
time," said Senator Carl Levin, chairman of the U.S. Senate
Permanent Subcommittee on Investigations, a Congressional
watchdog panel.

The report comes at a troubling time for a banking industry
reeling from a multi-country probe into the manipulation of
global benchmark rates. Last month, rival British bank Barclays
Plc agreed to pay a $453 million fine to settle a
U.S.-British probe into the rigging of the benchmark interest
rate known as the London interbank offered rate, or Libor.

The Senate probe provides a rare look at how HSBC responded
when confronted with numerous cases of suspect money flows.

The report caps a year-long inquiry that included a review
of 1.4 million documents and interviews with 75 HSBC officials
and bank regulators. It will be the focus of a hearing on
Tuesday at which HSBC and OCC officials are scheduled to
testify.

The bank and the regulator are expected to face tough
questions at the hearing about how the abuses were allowed to
continue, even after the OCC took regulatory action against HSBC
in 2010. A Reuters investigation found persistent lapses in the
bank's anti-money laundering compliance since 2010.

In an emailed statement, HSBC said the Senate report had
provided "important lessons for the whole industry in seeking to
prevent illicit actors entering the global financial system".

The bank said it is spending more money on compliance and
has become more coordinated in policing high-risk transactions.

The report also contained strong criticism of the OCC,
saying the regulator failed to crack down on the bank despite
multiple red flags, allowing money laundering issues "to
accumulate into a massive problem".

Thomas Curry, who took over as comptroller less than four
months ago, said in a statement on Monday that anti-money
laundering compliance "is crucial to our nation's efforts to
combat criminal activity and terrorism, and the OCC expects
national banks and federal thrifts to have programs in place to
effectively comply with these laws".

Curry said the Senate report had made a number of
"thoughtful" recommendations, "which we fully embrace".

LAX CONTROLS

The failings and lax controls inside HSBC included an
inability to properly monitor $15 billion in bulk cash
transactions between mid-2006 and mid-2009, inadequate staffing
and high turnover in the bank's compliance units, the report
said.

HSBC ignored risks in doing business in countries such as
Mexico, a country rife with drug trafficking, it said.

Between 2007 and 2008, HSBC's Mexican operations moved $7
billion into the bank's U.S. operations. According to the
report, both Mexican and U.S. authorities warned HSBC that the
amount of money could only have reached such a level if it was
tied to illegal narcotics proceeds.

The Senate probe also examined banking HSBC did in Saudi
Arabia with Al Rajhi Bank, which the report said has
links to financing terrorism. Evidence of those links emerged
after the Sept 11, 2001 attacks on the United States, the Senate
report said, citing U.S. government reports, criminal and civil
legal proceedings and media reports.

In 2004, Al Rajhi sued the Wall Street Journal, which had
published an article about U.S. and Saudi authorities monitoring
accounts. The article referenced Al Rajhi.

Al Rajhi said in response to a WSJ story that it
"unequivocally condemns terrorism". Al Rajhi and the paper
settled in 2004. The paper did not pay damages and stated that
it "did not intend to imply an allegation that (Al Rajhi)
supported terrorist activity, or had engaged in the financing of
terrorism", the Senate report said.

In 2005, HSBC told its affiliates to no longer do business
with the bank, the report said. Four months later, HSBC
officials reversed course, allowing affiliates to decide whether
to continue to do business with Al Rajhi.

A Middle Eastern unit of HSBC continued doing business with
the bank, the report said. HSBC ultimately stopped helping the
bank handle certain types of transactions, and HSBC compliance
officials rebuffed other HSBC bankers seeking to maintain ties
to the bank.

Then in late 2006, Al Rajhi threatened to yank all of its
business with HSBC unless it regained access to using HSBC's
bulk-cash transaction business, the Senate report said. HSBC
agreed to continue to provide the bank bulk shipments of U.S.
dollars until 2010 when HSBC exited entirely the bulk-cash
business.

Officials at Al Rajhi could not immediately be reached for
comment.

U.S. OPERATIONS

The focus of the Senate probe was HSBC's U.S. operations,
which has its main office in New York. HSBC used the U.S. unit
as a selling point to clients outside the United States, touting
its ability to handle U.S. dollar transactions.

Among HSBC's problems, the report described the bank's
compliance division as unable to battle the suspect money. High
turnover of top compliance officials made it difficult for
reform to take hold, the report said. Employees were
"overwhelmed" by a mounting number of suspect transactions that
needed review.

"We're strapped and getting behind in investigations," one
bank official wrote in June 2008. By that time, HSBC was cutting
costs to offset losses tied to subprime home loans and the
brewing financial crisis. In 2010, one disgusted top compliance
official threw up his hands and quit after less than a year on
the job, according to the report.

Typical of the problems inside the bank were transactions
tied to Mexico, a country the report said is "under siege from
drug crime, violence and money laundering".

HSBC, according to the report, helped move money for a
Mexican foreign-exchange dealer called Casa de Cambio Puebla
that served as a hub for laundered proceeds, according to the
report.

Between 2005 and 2007, there was a "growing flood" of U.S.
dollars moving between the exchange house and HSBC, setting off
red flags inside HSBC. Some bankers said the transfers were
legal. One said the money came from Mexican landscapers working
in the United States and routing money back home to their
families.

HSBC ultimately closed the account in November 2007 after it
received a seizure warrant from the Mexican attorney general
seeking money tied to the exchange dealer, the Senate report
said.

DEALINGS WITH IRAN

Some of the money that moved through HSBC was tied to Iran,
the report said, which would violate U.S. prohibitions on
transactions linked to it and other sanctioned countries.

To conceal the transactions, HSBC affiliates used a method
called "stripping", where references to Iran are deleted from
records. HSBC affiliates also characterized the transactions as
transfers between banks without disclosing the tie to Iran in
what the Senate report called a "cover payment".

HSBC "failed to take decisive action to confront these
affiliates and put an end to the conduct," the report said.

Between 2001 and 2007, more than 28,000 transactions were
identified by an outside auditor for HSBC that potentially could
have run afoul of laws that prohibit transactions with
sanctioned countries. Of those, 25,000 involved Iran. A smaller
number required additional analysis to determine if violations
of U.S. regulations had occurred, the report said.

At the heart of HSBC's failings was the fact that it served
as a hub for smaller financial firms needing access to the
global banking system, the report said.

In one example detailed in the Senate investigation, HSBC
continued to do business with one client that admitted to U.S.
law enforcement that it had failed to maintain an effective
anti-money laundering system.

The client, Sigue Corp, was a money processor in California,
the report said. In 2008, the company agreed to a so-called
deferred prosecution with the U.S. Justice Department and other
U.S. agencies where it admitted to allowing millions of dollars
of suspect transactions between 2003 and 2005. Undercover U.S.
officers, in a sting, even moved money through the company,
explicitly telling Sigue agents they were moving illegal drug
proceeds, the report said.

A day after the agreement was announced, David Bagley, the
head of HSBC compliance, sent a handwritten note to another bank
official, asking, "Obvious question--I assume they are not our
customer." Bagley is scheduled to testify on Tuesday at the
Senate hearing.

In fact, Sigue was an HSBC customer, and bank officials
internally discussed whether to close the account. One
compliance official recommended it should be shut down. In the
end, the bank kept doing business with Sigue.

In 2009, the Justice Department said Sigue had satisfied the
requirements of the agreement and a criminal case was dismissed.